How to Use Retirement Funds to Start a Business

Wednesday

Rolling over a qualified retirement plan is a good way to inject equity into your business without penalty.

NEW YORK (MainStreet) -- With access to credit still tough, small-business owners sometimes need alternative sources to fund a business.

Rolling over a qualified retirement plan is a good way to inject equity into your business without penalty, says Steve Stovall, vice president of business development at Benetrends, which helps entrepreneurs and small-business owners create funding strategies for their businesses.
With access to credit still tough, rolling over a qualified retirement plan is a good way to inject equity into your business without penalty.

"While the Small Business Administration says there are all types of loans available, to actually find a bank that will fund a lot of business opportunities is very different, and those actual lenders can be very few and far between. So if somebody is up against a time constraint or if someone doesn't a have a job, without creating debt or without pledging collateral activity, using the 401(k) rollover is a great way to go," Stovall says.

How exactly does it work?

Stovall: We create a C corp. on your behalf. We have your C corp. sponsor a qualified retirement plan. Your original retirement plan will transfer or roll over money to the new retirement plan, and that happens without tax or penalty. The new retirement plan then buys stock in the new corporation and the corporation will then have cash to acquire assets, whether they are goods or services, and the corporation uses that money as operating capital.

The only plans that are out of bounds are Roth IRAs or sometimes pension plans, but pretty much as long as there is a retirement plan that is composed of pretax dollars and allows for a lump-sum distribution of funds, those plans are fair game.

The IRS will not allow the Roth program rollover for a business start-up because Roth money is post-tax money.

When can this strategy be used?

Stovall: To start a business or recapitalize or purchase a business. For LLCs or an S corp. that recapitalize they could use the program but would have to change structure and become a corporation -- but it's very simple to do.

What are some key steps business owners should take once they decide to use this strategy?

Stovall: You want to start a business within 12 months of creating the retirement plan and the corporation. You will want to take a salary from the business as quickly as you can. You'll want to let your eligible employees know there is a retirement plan and ask whether they want to participate. You yourself will want to make contributions into the retirement plan within three years or as soon as you can.

What do you say to business owners who are nervous about taking out their money?

Stovall: You're pulling your money from marketable securities and you're investing in yourself. You run the risk of losing money on the market or on the business you start. A lot of people are more confident with their own skill set than what's been happening in the markets for the last few years.

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The fact that people don't have to use 100% of the money in their 401(k) or IRA also gives them the confidence they can still have something set on the side as a nest egg.

Are you seeing more inquiries, particularly as access to credit for small companies remains challenging?

Stovall: Yes, absolutely. The fact that money is so difficult to get makes people search more places to get it, but also the fact that franchisors, business brokers, consultants and the like are using our industry more and more just makes that many more inquiries come in. Even banks work with us because they understand people can use their 401(k) or IRA as an equity injection for a SBA loan that will get funded.

We help people open everything from auto repair shops to hair-cutting places to chocolate shops to liquor stores. So if you have a person that either is having trouble finding the money to start a business from external sources or wants to start a business and minimize their debt load or needs available capital as equity injection for the loan, we help solve a lot of problems.

We educate new people every week on the power they already hold. Not everybody knows about it. There are still a lot of people that have not seen the light, if you will.

What if the business fails?

Stovall: Let's say there are two ways to start a business -- by using a 401(k) or with an SBA loan. If the business does great, you replenish the 401(k) or you pay off the loan. If the business fails the bank doesn't care, the bank wants its money plus whatever interest rate the bank is charging you until you've paid off that money. Also, the bank is probably going to do something to force you to declare bankruptcy or another adverse situation.

By using your retirement plan, while you lost money -- this is true -- you can control the amount of money that you lose. And whatever money you can salvage you can put it back into a plan without taxes or penalty. It gives you a lot more control, even if things aren't going well.

-- Written by Laurie Kulikowski in New York.

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